During the pandemic, central banks all over the world began to ease policies, lower rates, and distribute more money into the market to prevent the economy from collapsing. The result of this was a policy error. The lowered rates and eased policies gave rise to an increased demand for products, employees, housing, and higher wages. Inflation started to increase significantly when Russia invaded Ukraine affecting oil and gas prices, as well as supply chain disruptions in China. As of right now, one of Canada’s main concerns is to avoid embedded inflation (also known as wage inflation), which is when workers demand higher wages to keep up with the rising costs of living. If inflation is embedded, more money goes into the economy, demand increases, and prices stay elevated. This is why the Bank of Canada (BoC) has been hiking rates drastically. If interest rates are high, people will hopefully spend less which will lower the demand.
The BoC has previously stated that the overnight lending rate needs to be at least 3.0% or higher in order to combat inflation. The overnight lending rate currently sits at 2.50% which means we can expect more rate hikes this year. Despite predictions from economists, it is unclear how much rates need to increase, and when they will begin to go back down.
What does this mean for current buyers in the market?
The qualifying rate of 2% above the contract rate is now being used rather than 5.25% (benchmark rate). This means that the stress test is hovering between 6.30%-7.30%. The increase of the prime rate has decreased affordability by 10%. As rates continue to rise, buyers are encouraged to monitor their pre-approval to ensure their affordability has not changed.
How does this affect variable rate mortgage holders?
Adjustable Rate Mortgage
Payments will adjust to reflect the new rate to ensure your amortization does not get extended.
(ie: Scotiabank, First National, RMG, or any other monoline lender)
Variable Rate Mortgage
Payments stay the same as when your mortgage was funded, but the allocation of principal and interest gets shifted. A static payment in a market where rates are trending up can result in a trigger rate and trigger point.
(ie: TD, Coast Capital, HSBC)
If you don't increase your variable rate payments, then there are two things you need to know:
Trigger Rate
This is when your monthly payment is 100% interest, causing the outstanding balance on your mortgage to increase. As a result, you may have a higher monthly payment upon renewal based on the renewal rate and remaining contractual amortization
Trigger Points
The trigger point is when the balance of the mortgage surpasses 80% of fair market value (for conventional mortgages) or 105% of the original loan (for insured mortgages). If the trigger point is reached, the bank will require either a lump sum payment, increased principal and interest payment, or convert to a fixed rate mortgage.
To avoid reaching the Trigger Rate and Trigger Point you can:
1. Increase Monthly Payments
This will ensure that you are making sufficient payments toward your mortgage without having to extend the amortization.
2. Lump Sum Payments
This will reduce the balance of your loan and allow you to keep your payments the same without having to worry about an increased payment at renewal.
What should I do as the rate continues to rise?
This year so far, we have seen drastic rate hikes in such a short amount of time. We understand that uncertainty can bring discomfort to many people, but please do not panic! The decision on whether or not to lock into a fixed rate depends on multiple factors and is specific to the individual. A client recently used the analogy that locking into a fixed rate right now feels like the same thing as selling his stocks because they keep coming down. The stock market, rates, and the real estate market go in cycles. What goes up will eventually come down! If you have any questions about your rate, or just want to chat about the market, please don’t hesitate to reach out to any of us! :)
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